Fifth Circuit rejects “passive investor” test for limited partners

Sirius Solutions, L.L.L.P vs. Commissioner. United States Court of Appeals for the Fifth Circuit. No. 24-60240.

The Fifth Circuit held that “limited partner” in § 1402(a)(13) means a partner with limited liability in a state-law limited partnership, not only a passive investor, and it vacated the Tax Court’s decision.

Holding

The Court ruled that § 1402(a)(13) excludes a limited partner’s distributive share from self-employment tax based on limited liability status in a limited partnership. It rejected the Tax Court’s “passive investor” functional test and remanded for further proceedings.

Why It Matters

• This creates a direct circuit-level split in approach with the Tax Court’s Soroban line, which treats “limited partner” as limited to passive investors.

• It strengthens the position that state-law limited partnership status and limited liability can control the § 1402(a)(13) exclusion, at least in the Fifth Circuit.

• It increases uncertainty for partnerships with active owners holding limited partnership interests because the Tax Court still applies a functional analysis.

• It pushes the fight back to statutory text and longstanding administrative practice, not multi-factor role tests.

Timeline

• 2014–2016: Sirius reported ordinary business income or loss and allocated it to limited partners. It reported $0 net earnings from self-employment.

• June 2020: IRS issued an FPAA for 2014. It increased net earnings from self-employment from $0 to about $5.9 million.

• June 2021: IRS issued FPAAs for 2015 and 2016. It increased in 2015 to about $7.37 million and left 2016 at a loss.

• February 20, 2024: The Tax Court upheld the IRS adjustments based on Soroban.

• January 16, 2026: Fifth Circuit vacated and remanded.

Key Facts

• Sirius Solutions, L.L.L.P., operated a consulting business based in Houston, with offices in Dallas and London.

• It was a Delaware limited liability limited partnership.

• In 2014, it had 9 limited partners and 1 general partner. For 2015–2016, it had five limited partners and the same general partner.

• Sirius allocated all ordinary business income to limited partners and treated that income as excluded from self-employment tax under § 1402(a)(13).

Statutory or Regulatory Framework

• § 1401 imposes Social Security and Medicare taxes on self-employment income.

• § 1402(a) generally includes a partner’s distributive share of partnership trade or business income in net earnings from self-employment.

• § 1402(a)(13) excludes the distributive share of income or loss of a “limited partner, as such,” but not guaranteed payments under § 707(c) for services actually rendered, to the extent treated as remuneration.

Arguments

Taxpayer argued:

• “Limited partner” in § 1402(a)(13) means what it ordinarily meant in 1977: a partner in a limited partnership with limited liability.

• The Tax Court’s passive-investor test conflicts with the statutory text and with decades of IRS and Social Security Administration guidance.

Government argued:

• “Limited partner, as such,” only covers partners functioning as passive investors.

• Federal tax meaning should not turn on state-law labels and should follow economic reality and nationwide uniformity.

Court’s Reasoning

• Contemporary dictionaries define “limited partner” by limited liability and limited partnership status, not by passivity.

• The “guaranteed payments” carveout assumes limited partners can render services. A strict passive-investor definition would make that carveout pointless or oddly narrow.

• Congress knew how to write “no services” or “passive” rules elsewhere in the Code and did not do so here.

• Longstanding IRS Form 1065 instructions and SSA regulations defined “limited partner” in liability-based terms for decades, which the Court treated as strong interpretive evidence under the post-Loper Bright framework.

• The phrase “as such” can do work without narrowing “limited partner” to passive investors. It can address people serving in multiple capacities, including limited and general partner roles.

Forward-Looking Implications

• Partnerships and partners litigating § 1402(a)(13) now have a strong appellate precedent to resist the Tax Court’s Soroban functional test, at least within the Fifth Circuit.

• Expect more forum and venue pressure. Taxpayers may try to posture cases for appellate review in circuits that might follow this textual approach.

• IRS examination positions built around the “limited partner equals passive investor” framework face a higher litigation risk in Fifth Circuit cases involving state-law limited partnerships with limited liability.

• The opinion leaves open how the rule applies to other entity types, such as LLCs and LLPs. That is where a lot of the real money fights live.

Result

The Fifth Circuit vacated the Tax Court’s decision and remanded for further proceedings consistent with its limited-liability interpretation of “limited partner.”

The Takeaway

If your client is a limited partner under state law and actually has limited liability, the Fifth Circuit says § 1402(a)(13) can exclude the distributive share from self-employment tax even if the partner works in the business. The Tax Court’s “passive investor” gloss did not survive in this appeal.

List of Citations

• 26 U.S.C. § 1402(a)(13): Limited partner exclusion from net earnings from self-employment, with guaranteed payment carveout.

• 26 U.S.C. § 707(c): Guaranteed payments rule referenced by § 1402(a)(13).

• Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023): Tax Court decision adopting the passive-investor functional analysis the Fifth Circuit rejected.

• Loper Bright Enters. v. Raimondo, 603 U.S. 369 (2024): Cited for independent judicial interpretation and the relevance of consistent agency interpretations.

• Bittner v. United States, 598 U.S. 85 (2023): Cited for skepticism when the government’s litigation position conflicts with prior public guidance.